Altria Group Inc. (NYSE: MO). The company manufactures and sells cigarettes, smokeless tobacco products, and alcoholic beverages in the United States and abroad. The company also pays a solid dividend with a yield of over 9%. However, Altria is facing pressure from legislative efforts to limit sales of e-vapor products. These efforts are likely to include restrictions on the level of nicotine and flavor options for e-cigarettes. While Altria still generates 89% of its revenue from smokeable products, including top-selling brands such as Marlboro, we believe that over time consumers will view vaping products as a more acceptable nicotine delivery system than traditional cigarettes or chewing tobacco, and that the use of these products will grow despite legislative restrictions. We caution, however, that negative legislative developments, including higher excise taxes, could result in a decline in share price.
The beta on MO is 0.55.
The gross margin as a percentage of net revenue rose 120 basis points to 52.2%. Operating income of $3.2 billion increased 7.3%. The net loss was $952 million, primarily due to the impairment of JUUL equity securities.
To date, Altria has recorded net pretax charges of $50 million (all of which were recorded in 2Q20), for costs associated with the virus or efforts to mitigate its impact, such as health screenings, PPE, and premium pay. The company has also recorded pretax charges of $415 million for inventory write-offs (grapes) in its wine segment. The company has also taken charges for its investments in JUUL ($2.6 billion), ABI ($689 million), and Cronos ($144 million). The fair values of the ABI and Cronos investments are now less than their carrying values. Altria believes that the fair value decline is temporary.
The company grows in part through acquisitions. In December 2018, Altria completed its 35% investment in JUUL, an e-cigarette company, for $12.8 billion. In August 2019, Altria acquired 80% of certain Burger Sohne Holding AG companies that commercialize oral nicotine pouches. In 1Q19, Altria purchased a 45% stake, with a warrant to acquire an additional 10%, in Cronos Group, a Canadian marijuana producer, for approximately $1.8 billion.
EPS growth this year. Altria also revised its expectations for domestic cigarette industry volume. It now expects industry volume to be flat to down 1.5%. It previously projected a decline of 2.0%-3.5%.
EARNINGS & GROWTH ANALYSIS
Altria has three segments, Smokeable Products (89% of 3Q20 revenue), Oral Tobacco (9%) and Wine (2%). Excluding the wine segment, net sales were up in the low single digits in 3Q on higher pricing.
The Smokeable products segment posted third-quarter revenue net of excise taxes of $4.9 billion, up 5.7% from 3Q19. The results reflected higher pricing, offset by higher promotional activity and a 1% decrease in domestic cigarette volume. The company’s total retail market share declined slightly to 49.4%. Marlboro’s retail market share of 43.3% remained unchanged from the prior year.
In the Oral Tobacco category, revenue net of excise taxes rose 3.4% to $607 million. The results reflected higher pricing, partly offset by higher promotional activities and a 1% decline in domestic shipment volume. The Oral Tobacco segment retail share was 49.9%.
In the Wine segment, revenue net of excise taxes fell 6.2% to $152 million due to a 3.9% decrease in shipment volume.
The operating margin in 3Q20 was 44%, up from 43% in 3Q19 primarily due to lower marketing costs. In an effort to boost profitability, Altria management has implemented programs to lower costs, including facility consolidation. In December 2018, Altria announced a cost-reduction program that delivered $600 million in cost savings last year, above its initial target of $575 million. The program included reduced spending and workforce reductions across Altria’s businesses.
FINANCIAL STRENGTH & DIVIDEND
Altria’s long-term debt is rated A3/stable by Moody’s. Standard & Poor’s rating is BBB/stable and Fitch’s rating is BBB/stable.
Altria pays a dividend. The company expects a payout ratio of approximately 80% of adjusted EPS in 2020-2022.
MANAGEMENT & RISKS
Billy Gifford joined Altria in 1994. He served as the company’s CFO and vice chairman, and in other leadership positions, before becoming CEO. Prior to joining Altria, Mr. Gifford worked at the public accounting firm Coopers & Lybrand. Sal Mancuso joined Altria in 1990 and held a number of senior roles in finance and accounting before being appointed executive VP and CFO.
Investors in MO face numerous risks, including the impact of increased excise taxes and weak consumer spending due to the pandemic. The U.S. cigarette industry has seen sales decline by about 2% annually over the past several years due to health concerns, higher taxes, and weaker consumer spending. As a result, Altria has focused on growing its smokeless tobacco, e-cigarette, and beverage offerings; however, the company is likely to face additional restrictions on e-cigarettes in the wake of recent deaths associated with these products. New FDA regulatory authority over tobacco products could also have a significant impact on the company and the industry.
Tobacco companies continue to face substantial legal risks and potential monetary liabilities in the U.S., though they have recently been successful in appealing and reducing damages awarded by the courts. In addition, given the lengthy nature of the appeals process, any damages awarded are likely to be paid many years after the original verdict. Ultimately, we do not believe that the states or the federal government want to drive the tobacco companies out of business and lose this rich source of tax revenue. That said, we expect Altria to face continued legal and regulatory pressure, both in the traditional cigarette and e-cigarette markets.
Altria has been investing in alternative products, notably through a licensing and distribution agreement with Phillip Morris for its IQOS heated tobacco product, and its equity stakes in Cronos Group and JUUL. Although cannabis is illegal at the federal level in the U.S., Altria management believes that the acquisition will position the company well if cannabis is eventually legalized. On April 1, 2020, the U.S. Federal Trade Commission filed an administrative complaint against Altria and JUUL to challenge Altria’s minority investment in JUUL. Altria intends to defend the transaction. In July, the U.S. FDA authorized IQOS and HeatSticks to be marketed as a Modified Risk Tobacco Products with a ‘reduced exposure’ claim.
The company recently revised the terms governing its 35% stake in JUUL. The agreement stipulates the services that Altria will provide to JUUL, and conditions for the inclusion of additional JUUL board seats to be held by Altria representatives. Altria will also be released from its non-compete agreement if JUUL is prohibited from selling in the U.S. for more than a year or if the carrying value of the JUUL investment falls to less than 10% of the initial carrying value of $12.8 billion.
Altria Group, founded in 1919, manufactures and sells cigarettes, smokeless tobacco products, and alcoholic beverages in the United States and abroad. Its cigarette brands include Marlboro, Virginia Slims, Parliament, Benson & Hedges, Basic, Merit, Chesterfield and L&M. The company acquired the U.S. Smokeless Tobacco Company in 2009, adding the Copenhagen, Skoal, Red Seal, and Husky brands to its portfolio. The company also spun off its international operations as Philip Morris International in 2008. Altria retains the Philip Morris USA segment, which focuses on the U.S. market and includes various cigar, pipe tobacco, e-cigarette, wine, and beer brands.
Based on the company’s strong brands and prospects for growth in cannabis and smokeless products (despite the likelihood of increased regulation), we believe that MO continues to merit a BUY rating.